Please note that tax, investment, pension and ISA rules can change and the information and any views contained in this article may now be inaccurate.
Boosting the return on your retirement savings
For many people, their private pension will grow to become their biggest asset, outside the home they live in, and yet the investments that drive the performance of these retirement plans often slip by under the radar.
Part of the problem is that we all associate pensions with retirement, and indeed, it’s in later life when these schemes start to pay an income. But the size of your pension pot, and consequently your comfort in retirement, is determined by the decisions you take when you are much younger.
Many of the obvious ways you can boost your pension pot require sacrifices. Making bigger contributions leaves you with less money in the here and now.
Starting pension saving earlier might compromise other financial goals you have when you are younger, such as saving for a house deposit, or paying down debt. And at the other end of the spectrum, for some people, delaying retirement will be a necessity brought on by inadequate pension planning in earlier years.
FOCUS ON RETURNS
There is one way to boost your pension however, which simply requires a little time and effort. That’s to try and improve your investment returns. To illustrate the difference it could make, after 30 years, a £200 monthly pension contribution would be worth £163,740 if it grew at 5% a year, but £235,210 if it grew at 7% a year, after charges.
Now we all know that there isn’t a magic money tree which is going to guarantee you better returns, but because of the way many workplace pension schemes are run, you may be able to considerably improve the performance of the fund you hold in it.
That’s because the default fund which is automatically chosen for you is done on a ‘one size fits all’ basis.
MIDDLE OF THE ROAD ‘PLODDERS’
Your employer has to pick a single default fund that is the least worst fit for the whole workforce, and unfortunately that often means these funds are simply middle of the road plodders.
They’re designed that way, because understandably employers don’t want to take risks when selecting a fund for hundreds, or even thousands of people. It’s a heavy responsibility.
But within your workplace pension there will usually be other investment options available, so it’s worth checking if there’s something which might be a bit better suited to you than a fund which was chosen for everybody in the workforce as a whole.
One thing to consider is the proportion of the default fund allocated to equities, and whether this is appropriate for you.
Default funds tend to have a fairly conservative asset mix, with up to 50% in cash and bonds. While that means lower volatility, it can also hamper long term performance.
This is particularly the case if you’re some way from retirement, and saving regularly, as this puts you in the ideal place to ride out the ups and downs of the stock market in search of higher returns.
ACTIVE OR PASSIVE?
Many default funds also take a passive approach to the markets they’re investing in. The benefit of this approach is it’s generally cheap, and limits the chance of extreme underperformance compared to the benchmark index.
However there will never be outperformance, and if it’s doing its job properly, a passive fund should be expected to underperform the index it is tracking by the level of charges that it levies.
For many people, the simplicity and low cost of passive funds makes them attractive, but if you invest in active funds elsewhere, then there’s no reason not to consider them for your workplace pension. There are some managers who have delivered exceptional outperformance over long time periods, though the trick is to pick those who will do so going forward.
A long track and successful record provides some measure of comfort that an active manager isn’t just a flash in the pan, though it’s not a cast iron guarantee that outperformance will continue in future.
As ever, there’s no obligation to choose one strategy over another, it is possible to combine a mix of both passive and active funds within one portfolio, or indeed one workplace pension plan.
As well as your current workplace pension, it’s as important, if not more so, to consider old workplace pension plans (though this doesn’t apply to defined benefit schemes like final salary plans). Unless you’ve selected otherwise, you may well be still invested in a default fund many years after you’ve left a particular employer.
And if your employer decides to change their default fund after you’ve left, your pension doesn’t automatically switch across as you’re no longer a member of staff. So you could end up in a fund which was selected twenty years ago by an ex-employer, even though they’re not using it for their current staff because they’ve found a better option.
Needless to say it’s worth taking a look under the bonnet of your old pensions plans to make sure you’ve investments are up to scratch by today’s standards, both in terms of performance and charges. You might also give some thought to consolidating them all in one place to make them easier to manage.
Doing so will likely take a bit of effort pulling all the paperwork together, but it will make the job of keeping an eye on things much easier in future. Given the current lockdown, it’s hard to think of a better time to spend a bit of time getting a grip on old pension plans.